Traditional Financial Methods For Calculating IT Value: Economic Value Added, TCO, Total Economic Impact, Rapid Economic Justification
Mon, July 15, 2002
CIO —
Economic Value Added (EVA)
"Net profit minus the rent."
Nuts and Bolts: As a metric, EVA equals net operating profit minus appropriate capital charges. Simply put, when managers employ capital, they have to pay for it, explains Gregory Milano, partner and management committee member in the EVA consulting practice of North America at Stern Stewart & Co., the New York City-based developer and promoter of EVA. By assessing a charge for the use of capital, EVA encourages managers to monitor assets as well as income, and keeps them aware of the trade-offs between the two, Milano says. If you’re evaluating a new ERP system, for example, EVA requires that you factor in all investments, including initial cash outlays, maintenance, and internal and external training costs, and take those as a charge against anticipated benefits, which might be increased revenue or reduced costs.
Using EVA as a yardstick to assess the performance of individual departments, including IT, on a monthly, quarterly and yearly basis can help with decisions on new projects. Conflicting and confusing goals (like revenue growth, market share or cash flow) are replaced with a single financial measure for all activities.
BancorpSouth has had success in eliminating multiple goals. "In the past, we looked internally at growth goals, efficiency ratios, pricing margins, market share and of course, on the external side, earnings per share, but there were no capital considerations. People would make decisions to get growth volume and wind up losing their shirt," says Will Newcomer, senior vice president of MIS at BancorpSouth, a six-state bank headquartered in Tupelo, Miss. By putting Hyperion Solutions’ EVA calculation tool on each branch manager’s desk, BancorpSouth can tell branches that they need to hit income goals and make back the cost of their capital?but still give them the autonomy to do it their way.
Word of Mouth: EVA is a good way to gauge the top-level impact of IT, says Alinean’s Pisello, but it’s difficult for many IT organizations to connect that high-end view with something like the purchase of a new server without using intermediate measures. BancorpSouth may be in the minority by using EVA as a full-blown valuation framework. Other companies feel more comfortable using it as a single metric that plugs into another valuation methodology.
Time and Money: As little as three or four months for small companies with clear financial data; a few years for full implementation in large, complex companies. Cost is commensurate with the size of the company and project, says Milano.
